Having discovered that this summer’s behemoth energy bill in fact did nothing to help with the problems uncovered by Hurricanes Katrina and Rita, Congress is ready to try again with HR 3893, which was reported out of committee last week. This one actually has some good ideas in it.
HR 3893 (hat tip: Green Car Congress) includes the following features:
Sites for new refineries. No new refinery in the United States has been constructed in the last thirty years, and half have been shut down. HR 3893 calls on the President to come up with a list of sites, of which at least 3 will be on closed military installations, that might be suitable for refinery location, and to secure contracts with companies to lease these sites for purposes of refinery construction. The bill also expedites the review process so that permits will be granted quickly. The DC Court of Appeals is given original and exclusive jurisdiction for civil actions related to a federal refinery authorization.
One can make a case that had such a measure been in place five years ago, this summer we would have had additional refineries in Yuma, Arizona and Santa Fe Springs, California. However, a more important factor than the difficulty in finding a site for a new refinery has been their low profitability [1] [2]. Reducing the risk and time factor of environmental litigation, as proposed by the bill, could certainly be helpful in terms of improving that profitability. But the bill also proposes that the government sell crude oil at up to a $4.50 discount to small refineries for further encouragement. This is the kind of corporate handout that we cannot afford given the magnitude of our problems with the U.S. budget deficit and is difficult to justify economically. I personally would much prefer a plan that makes sure that environmental regulations are thoughtfully developed in a way that rationally weighs costs and benefits, gives companies certainty about the nature of any liabilities they face and a quick time line around which to plan, but then lets the cards fall as they may in terms of whether investors then see adequate reward for new refinery construction without needing any direct handouts from Uncle Sam.
Harmonization of fuel standards. The bill calls for the EPA to come up with a list of only 6 gasoline and diesel blends to be used in the U.S. This strikes me as unambiguously a good idea.
Price gouging. The Federal Trade Commission is charged with investigating and prosecuting “price gouging” during times of national emergencies. The bill offers these guidelines for how that might be done:
In conducting its investigation, the Commission shall treat as evidence of price-gouging any finding that the average price of gasoline available for sale to the public in September, 2005 or thereafter in a market area located in an area designated as a State or National disaster area because of Hurricane Katrina… exceeded the average price of such gasoline in that area for the month of August, 2005, unless the Commission finds substantial evidence that the increase is substantially attributable to additional costs in connection with the production, transportation, delivery, and sale of gasoline in that area or to national or international trends.
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When you buy a stock or a house from someone, do you insist that you are being “gouged” if they sell it to you for a price that differs from their own cost? The price of anything– stocks, houses, gasoline, whatever– should depend on current economic conditions, not historical costs. In these emergencies, gasoline has become much more scarce, and consumers have to reduce consumption. That is the reality of the situation, and an act of Congress does not change that reality. The way that demand reduction is supposed to happen in the United States (though perhaps not in some communist countries) is for the price to go up. HR 3893 would guarantee gasoline shortages for the United States whenever there was a supply disruption that caused the necessary price of gasoline to differ from its historical cost.
Moreover, the whole premise of HR 3893 is that we need more refinery capacity in order to have a buffer for events such as Katrina or Rita. The way a market economy is supposed to provide an incentive for such capacity is to make sure that anyone who invested to create the capacity gets
rewarded financially when it is really needed. The “price gouging” clause of HR 3893 thus works directly to undermine the effectiveness of the rest of the act.
Despite these criticisms, HR 3893 is a vast improvement over the energy bill this summer, in part because, unlike the thousands of pages that the latter ended up consuming, HR 3893 is a lean and trim 67 pages. If the Senate would now cut it down to about a fourth of that, it might actually be a decent piece of legislation.
Why do we NEED new refineries? At least why within the US?
With so much of our crude oil imported, we might as well import refined products instead. Both come by tanker. With domestic extraction trending downward, we could use less domestic refinery capacity.
Offshore refineries would have a comparative advantage over US-sited refineries in that they may have less stringent environmental and health and safety standards so they could do business more efficiently.
There is something fishy about the sudden media coverage and government initiatives for new refineries. It would seem any intelligent, honest observer would see through this. The only gainers I see are the oil production companies since a shortage of refineries leads to monoposony market conditions for crude.
The only constructive point I see is the common fuel standards. A bigger market for a product usually leads to a lower cost of production through economies of scale.
The only two things that make sense are conservation and development of alternatives. Drilling in ANWR or building more refineries merely hastens the day when oil is depleted. It’s not that we don’t have enough refineries; it’s that we’re are burning too much gasoline thus consuming too much crude while creating too much CO2.
It seems to me that if we build enough refineries to have a good buffer to allow for 15-20% of them to be down when there are hurricanes in the Gulf, then refinery margins are going to suck whenever there aren’t hurricanes in the Gulf. Given that the refiners have only just gotten reasonable margins after years of trailing in the dust, it’s not clear that private investors have much real incentive to build more refineries (they’ve been closing or consolidating them for decades, for good reason – profits were terrible). This is still more so given the considerable uncertainties over future crude supplies, but even if that weren’t the case, at best it’s an extremely capital intensive but very cyclical business. It will not be lost on would-be refiners that consumers are suddenly buying small, fuel-efficient cars. My prediction is we won’t see any new refineries despite this bill. It probably makes good business sense to build more refineries in India or China, but not here.
The creation of an avenue to enable rational permitting of new refinery construction could be helpful in dealing with the NIMBY reaction of communities. However, we need only look at the Yuca Mountain project for the disposition of nuclear waste to realize that Congressional fiat is unlikely to resolve the problem.
While profitability issues in refinery operation have been an issue it is unlikely that government action is necessary. Examine the economic environment of the petroleum industry. The industry has the capital to deal with the issues of increasing the storm resistance of their facilities, and to expand facilities where needed. Refineries are a necessity to the product chain and the oil producers will invest in refineries to the extent necessary to provide a market for the resource.
Advocating off shore refineries place us in a very vulnerable position. We can find substitutes for Venzuelan crude, but if we rely on any country for a significant part of our gasoline supply we are setting the stage for the next war.
Bill
On the simple efficiency issue, shipping gasoline seems better. If you lose some fraction of a barrel of crude in the process of making gasoline, why ship it first?
Catching my eye: morning A through Z
Here’s what’s caught my eye this morning:
Dennis the Peasant contrasts how Ohio politics appears from Berkeley, California with how it looks in Ohio and, in the process, illustrates something I’ve noticed increasingly about the …
Interestingly enough, some members of congress and the administration (including the president) did not realise that there were no Federal laws against price-gouging laws. This bill aims to correct that but it is badly written in that it does not allow for scarcity pricing. California law allows for a 10% increase in pricing although some would argue that 10% vis too low. If the bill is implemented as is then, as JDH says, shortages will result.
I agree with Stuart’s claim that refinery margins will be low if additional capacity is built to provide a buffer for situations like Katrina. Since that extra capacity is a form of insurance, a mechanism must be devised to pay for it. In the electricity markets, this is done explicitly by setting a price for capacity. The idea of a $4.50 discount on the oil price for smaller refineries seems to be a poorly designed attempt at compensating refiners for their capacity.
The govt in some instances may need to come up with standards. Has the govt developed standards for fuel cells and other forms of alternative or renewal energy sources?
Also, harmony is a sometimes misused and abused word today. Often times “harmony” is used when words such as “fingernails scratching chalkboards” should be used. I am not saying this is necessarily the case with the energy bills.
Things like option value and diversification benefits need to be figured into a cost-benefit analysis.
EconoBrowser on Refining
Lynne Kiesling James Hamilton’s got a really nice discussion of a new House energy bill. His discussion highlights some aspects of the business of oil refining that I didn’t go into in my recent WSJ Econoblog, the most important of…
Joseph and Odograph, my understanding is that it is cheaper to refine the oil closer to the market, which is why you see Europe as one of the world’s major refining centers. In addition, Katrina and Rita have highlighted the security benefits of having more domestic refining capacity. One could imagine disruptions from a variety of other sources besides hurricanes that could also be problematic. There is also some evidence of a refining crunch at the global level, not just in the U.S. Finally, the specialization of fuel blends is another reason to do it domestically.
Nate, I use the term “harmonization” very simply to refer to more standardization of fuel requirements across communities.
If you are concerned with accidents, terrorism, naure, taking refineries off line it is much, much cheaper to store surplus emergency supplies then to build excess capacity — especially if you are trying to get the private sector to build it.
In 1999 Sun oil company — I believe –applied for permits to build the Yuma refinery. They
requested an excemption to existing pollution control requirements. In less then 6 months the request for exemptions was rejected. Sun did nothing until 2004 when they reapplied without requesting the exemption and they received rapid approval.
OK, did Sun wait five years to reapply because of the difficulty of the application process or because they did not expect to make money with the new refinery?
JDH
“rationalization” is different than “harmonization”
also, “harmonization” does not equal “standardization”. harmony can result in many notes. standardization moves toward 1 note, maybe 2 notes (or at less notes).
so if they are standardizing things, that is the word that should be used (not harmonizing).
A couple of points
Arizona Clean Fuels originally asked to build the refinery outside of Maricopa, just south of Phoenix. They got kicked out by the NIMBY crowd. They found another site outside of Yuma and started the process over again. That one has a shot at getting approved. Thats what took an extra five years the fact that they couldnt get approval of the original site.
One reason why we need refineries here rather than overseas is that crude oil is more efficient to transport than refined products. During the refining process there is a volume gain as the bottom of the barrel is cracked into lighter products. Crude is more dense and takes up less volume than refined products. Thats an advantage in shipping.
A New Energy Bill…
…that, unlike its predecessor, may actually do some good. HR 3893. (1) REQUIREMENT.Not later than 90 days after the date of enactment of this Act, the President shall designate sites on Federal lands, including closed military installations, that ar…
“6 blends of fuel”.
Is this 6 summer blends and 6 winter blends, or 3 summer and 3 winter?
I sense that this response is not “unambiguously” good, since it will result in either:
(a) some people paying more and some people paying less than they currently pay, with the aggregate welfare change not necessarily positive, or
(b) increases in emissions in urban areas, with resulting increases in low-level ozone and smog formation.
Furthermore, if you still use the “clean” blend in Louisville, but nowhere else between Chicago and DC, you’re not really solving the problem of high prices and potential shortages in Louisville.
The single best thing that could be done is to get rid of the ethanol mandate, at both federal and state levels, but politically speaking, that’s poison.
Scott:
Your stastement about the higher density of crude is true, and is an issue when we’re talking about shipping from the ME or Europe. But if those new refineries are in Jamaica or the USVI or (in a few years) Cuba, then the shipping cost difference becomes pretty trivial.
Another place we might see new refineries, when they become viable, is in maquiladoras in Laredo and Tijuana.
As to refineries cheapest nearest end-user markets, I remain skeptical. Shipping of a commodity like crude is relatively fungible – I suppose ALL crude carriers can carry ALL crudes with little hassle. I could see special tankers for gasoline, another class for jet fuel, etc but I think that’s a second order effect.
More likely, Europe’s concentration of refineries is an artifact of the technological skills required and their being an early adapter. Vertical integration might also account for some of the concentration too.
An analogue might be Brussels diamond cutting, a concentration we’ve seen dispursed of late.
Sorry, but I still haven’t heard a persuasive case for more domestic refineries. But I’m still listening…..
Joseph Somsel (and others) are right that shipping product is more expensive than shipping crude. I am sure that a dollar per barrel or so needs to be added to costs of product imports. For this reason, traditionally almost all refining has been built near (expected) consumption.
However, if a refinery could save a year in permitting time, this could more than make up for additional shipping costs. There are other market and regulatory issues as well – some mentioned above.
Saudi Arabia, or other crude producers, also benefit from vertical integration. This is especially true when refining a unique or low quality crude stream. This same phenomenon is occuring in petrochemical where companies (or countries) that don’t have their own oil or gas source are squeezed between two commodity markets. Most new petrochemical facilities are build by companies in oil or gas producing countries (China excepted).
I would expect that oil producing countries could gain enough benefits – from access to resources and control over construction time – to refine gasoline and diesel for export. Other oil consuming countries may invest in extra production to export to us. I don’t see large-scale greenfield develop for pure exporting purposes.
Building more refineries facilitates consumption of a finite resource.
Jack:
The term “near” is a little ambiguous in the statement “almost all refining has been built near (expected) consumption”.
The big exception is in the US, where much of the refining is concentated on the Gulf Coast, but sends much of its product to other parts of the US. The Gulf Region (PADD III in DOE-speak) consumes about a third of the gasoline produced there. PADD I (The North-East) only produces about a third of what is consumed there. About 50% of the NE gas comes from the Gulf Coast, and about 15-20% is imported from overseas.
Of course, this is not really an expensive problem because there is a huge gasoline pipeline that runs from Houston to New York. However, it does take about three weeks for gas to travel the full length of the pipeline, so refinery outages in the north-east cannot be instantly replaced with new production in Texas. I don’t think it takes a tanker three weeks to get from The USVI to NYC.
Ken Melvin,
Yes, there may be something to that, especially over the long payback period for a new facility. The impact could be less for countries that possess oil or gas and could favor their own refineries.
Barry P., transporting gasoline by pipeline is significantly cheaper than by tanker. I believe the most efficient arrangement is to have the refineries near the port where the crude is unloaded, and ship it from there to market via pipeline. The problem is that we can end up with all the refineries in the same hurricane-prone areas.
Yes, I agree. Refineries need to be located near a port where they can easily ship products to consumers.
Does anyone know if landlocked countries (Switzerland) tend to import more refined products? Is there a large transportation premium?
(Anonymous above was me)
All new refineries should be located near the coal deposits that they turn into clean gasoline and diesel!!!